How Fracking Affects Natural Gas Prices

Hydraulic fracturing – "fracking" – is a sometimes-controversial method of extracting natural gas. It's come to the attention of the public because of its effects on local water quality and even seismic disturbances. But whatever you think of fracking, it has done one thing: keep the price of natural gas from increasing more than it has.

Unlike oil, natural gas is a local market. That is, the amount produced in the U.S. – or more accurately, the U.S. and Canada – has a direct effect on the price. That's because natural gas, being, well, a gas, is difficult to transport without a pipeline. It can be liquefied, but that costs money. It's far cheaper to build a pipeline to the customer.

Fracking Way Back

Fracking is pumping a fluid into a well in order to break up the rock that bears oil or gas to release the hydrocarbons trapped inside. It's been happening in natural gas extraction since 1949 – a pioneer was an early iteration of Halliburton Co. (HAL) – and the technique itself dates back much further than that in the oil industry.

However, it wasn't until the 1970s that large-scale hydraulic fracture became profitable, and more importantly, was being done in areas where the rock wasn't porous enough for conventional drilling to work at all. What was once a supplementary technology became a primary one. Combined with horizontal drilling it opened up whole new areas for gas exploration. Shale formations, for instance, would ordinarily not release enough gas or oil to be worth it. Fracking changed that. Over the last forty years, as conventional wells have been played out, fracking has become the way most of the gas in the United States is produced.

Extracting Tight Gas

The Energy Information Administration, part of the U.S. Department of Energy, doesn't track the method of extraction for individual wells, but the type of gas is a good proxy for how important fracking has become. "Tight gas" and "shale gas," which are the types that fracking almost always used to extract, were basically insignificant in 1990. That year shale gas was a non-factor, accounting for 0.71 trillion cubic feet of the 17.81 trillion total produced. Tight gas was 1.81 trillion cubic feet. Combined that was about 14%. By 2013 shale gas and tight gas were 5.23 and 9.35 trillion cubic feet, respectively, or 60% of the 24.19 trillion cubic feet of natural gas produced in the U.S. That amounts to a 36% increase in production over two decades, largely driven by fracking.

Philip Budzik, a research analyst at the EIA and one of the contributors to the agency's "Energy Outlook 2014," an annual report that projects energy use and production, said fracking was a big reason that natural gas prices are as low as they are, even though they went up and reached a peak in 2008.

Now Extractable...And Cheap

"You look at the Marcellus Shale, and in 2008 it was producing maybe half a billion cubic feet per day, and now it's producing something like 16 billion cubic feet per day," he said. "The reality is when we were making projections back in 2000 we thought prices would be a lot higher than they were. What happened was trillions of cubic feet of gas that we thought weren't extractable."

The Marcellus Shale covers a wide area stretching from upstate New York, through Pennsylvania an southeastern Ohio, and into West Virginia. The EIA said that in August (2014) the Marcellus shale was producing 15 billion cubic feet per day through July, and accounting for 40% of the shale gas production in the country.

That makes a difference in wholesale natural gas prices. Prior to the increased exploration of the Marcellus Shale, a lot of natural gas to the Northeast was shipped in from the Gulf Coast.

Pricing Differential Says It All

The price, called "Henry Hub" was named for a distribution point in Louisiana, currently owned by Sabine Pipe Line LLC, a division of Chevron Corp. (CVX) One way to measure the effect of the Marcellus Shale is to look at the differential between the Henry Hub price and distribution points closer by, such as Dominion Resources, Inc.'s (D) Dominion South or TCO Appalachia, owned by Columbia Gas Transmission Corp.

According to EIA data, the spot price of natural gas delivered through the Dominion South natural gas trading point (located in Pennsylvania) was as much as 40% cheaper than that from Henry Hub. In 2007, the gas was up to 20% more expensive. The fact that the Marcellus is producing natural gas locally is a big reason why the northeastern U.S. may be one of the cheaper places to buy it.

The Marcellus shale isn't the only such formation. Others, such as the Bakken in North Dakota, Eagle Ford and the Permian of Texas, have showed net increases in gas production over the last several years, and much of it is driven by "unconventional" drilling – that is, fracking.

Prices across the board reflected the increased production. A look at the annual wellhead price of natural gas over time shows a peak at $7.97 per thousand cubic feet in 2008. For residential users the peak occurs at the same time, hitting $13.89.

As Production Rose, Prices Fell Off A Cliff

It was just after that, about 2008-2009, when the Bakken, Eagle Ford, Marcellus, and Permian shale gas areas started seeing a big increase in the number of wells dug. The peak price at the wellhead dropped all the way to $2.66 by the end of 2012, while the average 2013 price for residential users went to $10.33.

It's worth noting that the current prices are well above what they were decades ago – in the late 1960s residential gas was about $1.04 in current dollars. But the demand has also gone way up as the U.S. has tried to reduce dependence on foreign oil and electric utilities have switched to natural gas from coal. Natural gas-powered buses are becoming an increasingly common sight as well. The pressure on supply, therefore, is not abating.

The Bottom Line

Natural gas is cheaper than it would have been without fracking, even though the price has gone up. And with production still surging, it could stay that way for a while unless America starts exporting in great quantities.